The 20-Year Experiment Holding America Back

As the economy struggles with inflation and now a recession, it’s time to curtail the Sarbanes-Oxley Act.

By John Berlau and Josh Rutzick. Excerpts:

"Twenty years later, legitimate entrepreneurs and ordinary investors are punished by the law’s costly mandates. Sarbanes-Oxley has permanently altered the landscape of business growth and development.

Before the law, midsize and even small companies could go to major stock venues for early growth capital. Many retail investors then grew in wealth as the companies succeeded. When Walmart went public in 1970, the chain had 38 stores, primarily in Arkansas and Missouri. When Home Depot went public in 1981, the chain had only four stores, all around Atlanta. The initial stock offerings of both firms was less than $10 million. Today, their market capitalization exceeds $300 billion each.

These companies weren’t anomalous in going public at the early stages of their growth. This was the norm. A report by President Obama’s Council on Jobs and Competitiveness found that in the 1990s, 80% of initial public offerings were smaller than $50 million. By 2010, 80% of IPOs exceeded $50 million. In recent years it has been fairly common to see companies—including Uber, Lyft and Robinhood—go public with IPOs in excess of $1 billion after they had already become household names. Retail investors didn’t get to share in the growth of these companies before they became giants.

The costs of Sarbanes-Oxley are responsible for much of this shift in the size of newly public companies. Academic studies and annual reports show that the law has caused auditing costs to double, triple or even quadruple for many companies. A 2009 study by the Securities and Exchange Commission found that smaller public companies have cost burdens more than seven times those of large ones.

The disproportionate burden on small and midsize companies has spurred bipartisan criticism of Sarbanes-Oxley. As the Obama administration council noted: “Regulations aimed at protecting the public from the misrepresentations of a small number of large companies have unintentionally placed significant burdens on the large number of smaller companies.”

One of Sarbanes-Oxley’s most onerous mandates stems from the two brief paragraphs that constitute Section 404, which requires that public companies have effective “internal controls.” The Public Company Accounting Oversight Board, a quasipublic rule-making agency created by Sarbanes-Oxley, has interpreted this section to mean full-blown audits of any company process that could enable “a reasonable possibility of a material misstatement in the financial statements.”

This extremely broad standard, which reaches into all manner of company operations, has proved vexing particularly for businesses attempting innovation. According to John Battelle’s “The Search,” a history of the early years of Google, Sarbanes-Oxley was “hell for a company like Google, which made its money literally pennies at a time, from millions upon millions of micro-transactions.” Mr. Battelle reports that “internal control” compliance significantly delayed Google’s IPO, as the company “had to significantly restructure its advertising report system from the ground up.”"

"Home Depot co-founder Bernie Marcus has stated repeatedly that he doesn’t believe the company could have succeeded had Sarbanes-Oxley been in effect, as going public is what gave Home Depot the capital to open more stores."